ADDvantage technologies (AEY) is a distributor of electronics and hardware for the cable industry. Despite a history of consistent profitability and decent ROIC, the company currently trades at multiples that imply a bleak future where they will basically destroy shareholder value.I first discovered this idea from the excellent barelkarsan.com, and I encourage you to read his thoughts on the company.
Currently, the company trades for a market cap of ~$30m, slightly below its book value of $34m. Most companies that trade at a discount have a history of poor returns and a future of, at best, modest profitability. However, this isn’t the case with AEY- pretax ROA has average over 17.5% over the past five years, and the company has been profitable every year for the past ten. Operating income over the past five years has average just under $8.5m and never come in below $5.8m. With a current EV just below $35m, the company trades at just over 4 times EV / average 5 year EBIT and around 6 times EV / trough EBIT.
There’s a lot to like about AEY. Management seems rational (direct quote from Q4 2010 conference call “we chase profits and we don’t chase revenue) and owns ~50% of the company (split pretty evenly between the Chairman and the President / CEO). The company also recently modified their relationship with Cisco. Now, instead of buying directly from Cisco, they will buy from Cisco’s primary stocking distributor. While this will result in “slightly higher product cost” (Q1 2011 conference call), they are now a “Premier Partner” which will allow them to sell IT equipment in addition to Service Provider Video Technology Group (SPVTG) products. The increase in product cost should be somewhat offset by a decrease in inventory costs.
My take
The company is really, really cheap. Even if it was in a dying industry or faced a future of bleak ROIC, it’d likely be too cheap. However, it doesn’t seem to be a dying industry; actually, as the economy continues to improve, the industry could enter a period of strong growth. One of the most interesting things is the new distribution agreement. It’s possible the agreement could result in lower profits but still increase the share price. How? AEY currently holds ~$29m in inventory, over 50% of their assets. They note that the new agreement will allow them to reduce their investment inventory, which would free up cash for potential share repurchases or dividends and increase their ROIC by reducing their invested capital. I’ve initiated a small position in AEY, and would increase my position if the share price pulled back or as cash from other investments gets freed up.
Note- some of you may worry about investing in a company that distributes technology products. With a huge portion of their assets in inventory, a new technology shift could wipe out most of their assets and cause huge losses. While this is a risk, I don’t think it’s a huge one. Management notes that very little of their inventory has software in it (software is what makes inventory really exposed to obsolescence, and over 90% of their inventory has no software), and most of their inventory has VERY, VERY long shelf lives (they still have some inventory of products that were discontinued 5+ years ago that companies are ordering). Management does not seem concerned with it and notes that it’s never really been a problem for them (in over 20+ years in business), so I’m not terribly concerned with it.
Disclosure- Long AEY
Bringing you the content on this site involves a significant amount of time and effort. If you like my work, please support my site by shopping at amazon.com! Doing so costs you nothing (the prices are the same as if you went to amazon directly) but results in referral fees for me that I use to support my site.
Disclaimer
The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. Read that last line again. Also, this blog is not a solicitation of business. The content herein is intended solely for the entertainment of the reader and the author(s).
No related posts.
Follow me on Twitter
AEY’s business model is to aggressively stock large amounts of near-obsolete and rarely used equipment that Cisco and Motorola themselves do not stock in bulk, and sell them to the smaller players in the cable industry which are too small for Cisco and Motorola to bother stocking inventory for. They also buy back older legacy equipment from cable companies and refurbish them for the smaller players. The large risk of inventory write-down is why the company is trading at below book value, and the consolidation among the cable industry also does not bode well for the company. Add to that signs that owner-management has related party leases and relatively high compensation, and I’m more inclined to consider this a value trap. A distributor’s economic role should be good logistical systems. AEY simply has nothing to add except for its willingness to stock old equipment in bulk that other companies are not willing to stock, for obvious reasons. Just my two cents.
Thanks for the thoughts!
I don’t think it’s all near-obsolete and rarely used equipment is fair. It looks to me (from a review of their website and product offerings) like they also sell a decent bit of new equipment. I understand the worries over not basing their business on logistics, but the thought process behind stocks inventory and being able to fill rush orders makes sense to me to, and historically they have been very successful with it and write offs have not been a problem.
The related party leases are troubling, but they are small in context of the entire company.
It’s not a huge position, and I understand the concerns. But it’s tough to find a stock this cheap with such consistent levels of profitability and above average ROIC. They usually need to have some “hair” on them before they get this low. But they really don’t have much “hair” on them considering how cheap they are both to their present and especially past level of earnings.
they also seem to be focusing a little more on logistics/efficiency, talking about fully automated inventory management systems. Cost cutting seems to be another focus of the current strategy.
One thing I’d like to add to your post, which I think makes AEY attractive from a margin of safety perspective, is the fact that bother revenues and net margins are at depressed cycle lows and if revenues do come back, there should also be an improvement in net margins, as AEY is able to generate more revenue with the exisiting working capital. So upside is great if conditions are right while downside is limited.
Lastly, Management seems willing to repurchase stock when it gets too low (as they did in 2008). The recent large cash build up should provide them with the liquidity to perform similar actions if their stock price stumbles again.
On the other hand the cash-build up is somewhat confusing. They are reducing inventory levels (in line with revenues, I guess) and instead of returning cash to shareholders they are building up a sizeable cash position relative to historic levels, as well as their liquidity/working capital needs.
Any thoughts on managemnt strategy regarding this?
[...] I began looking at ADDvantage Technologies a month ago. It trades for less than tangible book, 1.05x NCAV and has a EV/E of less than 10. ADDvantage Technologies has been written up by Saj Karsen here and more recently by Whopper Investments here. [...]
[...] I do think the company’s too cheap, but there are so many huge tail risks here that I just can’t invest in it. You’re exposed to customer concentration on two fronts (Fedex and Air Force) and a segment that accounted for 10% of revenue losing 70%+ of their revenue. There’s just so much that could go wrong here that I don’t think you have quite enough margin of safety. That said, management seems excellent, the company has a very solid history of profitability, and I don’t think there’s much capital allocation risk here. I like the company, but I’d personally prefer AEY at today’s prices. [...]
[...] Using conservative scenarios, I value AEY in the $4-$6 range, nearly a double from the recent price. The $2.43 NCAV provides downside protection. Saj Karsan and Whopper Investments have recently written about AEY here and here. [...]
From their quarter results:
Net refurbished sales decreased $2.4 million, or 47%, to $2.7 million for the six months ended March 31, 2011 from $5.1 million for the same period last year. The decrease in refurbished equipment sales was primarily due to a decrease in sales of digital converter boxes of $1.5 million and the factors discussed above. The decrease in sales of digital converter boxes is primarily due to lower demand in the market and market price erosion.
But on the other hand:
Cost of sales as a percent of revenue was 69% for both the six months ended March 31, 2011 and 2010.
Now I can not understand if they say that refurbished sales dropped almost by half due in big part to price erosion of their set top boxes then how is it possible that their margins are unaffected? If their set top boxes have now a much lower sales price (due to price erosion) but their inventory cost is the same then the profit margins should be smaller but the margin is exactly the same that does not make sense to me. Can someone explain?